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Should You Buy Rio Tinto Group (LON:RIO) For Its Dividend?

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Is Rio Tinto Group (LON:RIO) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With Rio Tinto Group yielding 5.4% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock equivalent to around 4.9% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

LSE:RIO Historical Dividend Yield, December 23rd 2019
LSE:RIO Historical Dividend Yield, December 23rd 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Rio Tinto Group paid out 41% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Rio Tinto Group paid out 68% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's positive to see that Rio Tinto Group's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Consider getting our latest analysis on Rio Tinto Group's financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Rio Tinto Group's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$1.15 in 2009, compared to US$3.16 last year. Dividends per share have grown at approximately 11% per year over this time. The dividends haven't grown at precisely 11% every year, but this is a useful way to average out the historical rate of growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see Rio Tinto Group has been growing its earnings per share at 32% a year over the past five years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.

Conclusion

To summarise, shareholders should always check that Rio Tinto Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Above all, we're glad to see that Rio Tinto Group pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Rio Tinto Group has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 23 Rio Tinto Group analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.